Price targets are stupid

Barry Randall manages the
Crabtree Technology model on
Covestor, an online marketplace for investment management. He is founder and
Chief Investment Officer at Crabtree Asset
Management, a registered investment adviser based in Saint Paul, MN. With 18
years in the financial services business, Barry has progressed from junior
sell-side analyst to award-winning senior portfolio manager, personally
responsible for public and private portfolios holding as much as $650 million in
assets.

It's not enough to simply think a stock is a buy, sell or hold. Heck no. The analyst has to pinpoint exactly where (and sometimes even when) a stock will hit a particular price.

Am I alone in thinking that this is insane?

It's nuts for three reasons. The first reason is that it assumes the analyst (or pundit or strategist or whoever) cannot only predict the future, but also predict how investors will feel about it. Or put another way, the analyst is not only taking a crack at predicting a company's future earnings, but also the multiple that will be put on it.

But this is ridiculous, and examples abound showing why. Did the analysts covering, say, LinkedIn
LNKD
take into account that the sudden post-IPO drop in demand for Facebook
FB, +0.82%
would affect demand for LinkedIn, causing the price of LinkedIn shares to tumble precipitously? Having read a large amount of LinkedIn research, I'm qualified to tell you the answer: No, they didn't.

In fact, most of the analysts covering LinkedIn contemplated the exact opposite scenario: that any drop in Facebook's price would happen because its business model was weaker than LinkedIn's. In a zero-sum game, Facebook's loss would be LinkedIn's gain. In fact, the relative valuations (Facebook trading at a forward P/E ratio of 44 vs. 98 for LinkedIn), neatly demonstrated the analysts' confidence in LinkedIn. Confidence that proved to be unwise, as Facebook, LinkedIn, Zillow, Zynga and pretty much every Web 2.0 social media property declined sharply over the last month.

In other words, whatever multiple that analysts were putting on shares of these companies didn't seem to account for the relationships among them. Like the fact that mutual funds and ETFs held multiple players in each class, making redemptions bad for all of them. Oops.

A second reason price targets are crazy is easier to grasp: the problem with predicting the future in general is... all the things that will happen between now and the future. Sure, analysts can roughly gauge a company's revenues and expenses, and through them its future earnings. And if nothing happens between now and the future, great. But lots of things do happen. Mergers. Product launches by competitors. Executive departures. Black Swan events - positive ones like the emergence of fracking and tragic ones like 9/11.

If we lived in a vacuum, all companies would hit their targets. But we don't.

The third and most important reason price targets are insane is that the price of anything (stocks included) is determined by supply and demand. Yet neither Street analysts nor the media make any attempt to gauge supply and demand when throwing out price targets.

How do you know that the stock you want to buy isn't being sold right now by some new portfolio manager at Fidelity, who's liquidating a seven % position held by her (fired) predecessor? She can sell at will because her performance won't start counting until she's got the portfolio where she wants it.

How can you be sure that stock you just shorted isn't being bought by some multi-billion-dollar hedge fund's "black box," whose algorithms are suddenly impressed by the changes in some obscure financial factor? You do know that more than 70% of all shares traded on equity exchanges in the U.S. are done so by high frequency traders, right? That means that supply and demand are essentially controlled by "investors" whose quantitative tools are not only unfathomable, but change continuously. Good luck with that.

The bottom line is that whether you're a trader or an investor, the future price of the stock you're thinking about buying is a mystery wrapped in an enigma wrapped in a price target. Short term price appreciation (or depreciation for short sellers) is going to occur for reasons related to supply and demand, two factors about which you have basically no knowledge. So be prepared for uncertainty, as you wait for your fundamental or technical analysis to play out.

Hopefully you get the picture now: never let some overconfident Wall Street analyst put your smiling face in the middle of a price target.

This commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.

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